What are Pooled Funds?
Pooled funds is a term used to collectively refer to a set of money from individual investors combined, i.e., “pooled” together for investment purposes. The funds are combined with the intention of benefiting from economies of scale through cost minimization. Some examples of pooled funds include, but are not limited to, hedge funds, mutual funds, and pension funds.
The rationale behind instituting pooled funds is to benefit from economies of scale that arise out of gathering large funds from several individual units. The benefit comes in the form of cost minimization and expansion of investment opportunities.
Pooling funds together is an attractive option for investors because it makes new investment opportunities available to them. Collectively, they are able to purchase more shares than they can as an individual investor with a lesser amount of money.
How They Work
Pooled funds work in a very basic fashion, just like any other investment fund. Money from several individual investors is aggregated into one single account or pooled investment account. The investments out of the funds are treated as though they were from a single account holder.
What is a Trust Indenture?
A trust indenture is a legally binding agreement between the members of a pooled fund. The agreement clearly defines the roles of individual investors, management rights, distribution of earnings and dividends, fee limits and structure, and many others. It is instituted with a view to clearly define investor roles and earnings ratios in order to limit confusion and conflicting opinions in the future.
Importance of Pooled Funds in Financial Markets
1. Opens new investment opportunities
As mentioned earlier, pooled funds are an attractive option for investors because they open up new investment opportunities that were not initially available to them as an individual investor.
2. Economies of scale
Pooled funds bring economies of scale in the form of larger, better investment opportunities, along with cost minimization.
Pooled funds are considered a very profitable investment opportunity. It is because of the large amount of funds available in a single account that enables investors to create a diverse portfolio. A diverse portfolio allows investors to reap the benefits from different sources of investment.
4. Low exposure to risk
When several individual investors combine funds, it makes a substantial amount of money available for future investments. Hence, the availability of more funds allows investors to invest in several securities. Hence, if an investment underperforms, the risk is covered by the diverse portfolio of investments available to them.
Limitation of Pooled Funds
One of the limitations of pooled funds is the potential for conflict among their investors. Since a fund involves several individual investors working together, it can lead to disagreements and differences of opinion. Also, it can result in a lack of control over investment decisions and can undermine an individual investor’s opinion.
CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: